Energy and climate experts as well as national and EU parliamentarians are lining up to press their governments to withdraw from the Energy Charter Treaty (ECT) if insufficient progress is made in its modernisation. Their main argument is that it gives protection to fossil investments in a world where policies are changing in order to constrain or phase them out. Here, Frank Umbach at EUCERS sternly warns against abandoning the ECT. The treaty protects all energy investments, including the clean ones as well as minerals and other infrastructure. But Umbach also wants the critics to look beyond that to the ECT’s ability to promote the rule of law in places like Central Asia, Africa and other parts of the world where a stable investment environment is essential to their (and our!) transition plans. He provides a thorough summary of the issues, including the ECT’s purpose, the guarantees it gives to large and long term investments, the benefits of fair compensation, the multiple dangers of withdrawal from the ECT, and provides case studies from Germany, Kazakhstan and Russia. The global transition needs more, not less, cooperation. That’s why modernisation, not abandonment, must be the answer, explains Umbach.
In an open letter, more than 150 energy and climate experts have recently called on the EU to withdraw from the Energy Charter Treaty (ECT) with its 53 contracting parties and to disband the treaty. Already before last September, also 150 lawmakers of the European and national parliaments in the EU (mostly belonging to green, socialists, leftists, and liberal political parties) have also argued to jointly withdraw from the ECT by the end of last year if no progress is being made in the negotiations for a modernisation of the ECT. In their view:
- the ECT is hindering a rapid energy transition to a non-fossil fuelled based energy system as it protects fossil fuel investments such as in coal mines, oil and gas production, pipelines refineries and coal as well as gas power plants;
- the protection of fossil fuel investments would contradict the Paris Agreement on Climate Change of 1995 and the EU’s newly proclaimed European Green Deal (EGD) of December 2019. Hence the EU shall end any protection of investments in fossil fuel projects in the ECT;
- Business interests use the ECT to pressure states not to increase environmental and social protections;
- the ECT would also allow private companies to sue governments for damages to their private energy investments being hurt by new legislation. It hinders to adopt new legislation, leading to a “regulation chill”;
- those suits for investor-state dispute settlements would be heard in private, non-transparent arbitration hearings, and not public courts.
The following analysis provides additional arguments, particularly by highlighting the EU’s foreign policy interests, to Andrei Belyi’s Energy Post article of last September which explains why terminating the ECT by the EU would be short-sighted, not thought-through, counterproductive, and not achieving the critics’ proclaimed objectives.
Disbanding the ECT would be contrary to the EU’s strategic interests in its neighbourhood and global foreign policy agenda (such as promoting the rule of law in partner countries) and not contribute to any faster decarbonisation of the energy systems neither in the EU nor in other member states of the ECT.
Purpose and Objectives of the ECT
The ECT is a multilateral framework for energy cooperation designed to promote energy security through more open and competitive energy markets, respecting the principles of sustainable development and sovereignty over energy resources, based on the principles in the Energy Charter – a political declaration adopted in December 1991 and originally designed for a fossil-fuelled world. It had been ratified by the EU and its member states in 1998.
Key clauses of the ECT concern protecting investment, trade in energy materials and products, transit, and dispute settlement. The contracting parties to the treaty have also agreed to promote energy efficiency, and to minimise the environmental impact of energy production and use. The polluter should, in principle, bear the cost of pollution, including trans-boundary pollution, without distorting investment in the energy cycle or international trade. Private investors (including pension funds involving public sector employees) also rely on the ECT to defend their investments in renewable energies.
Furthermore, The ECT also includes provisions for resolving disputes between participating states through diplomatic channels and ad hoc tribunals, and — in the case of investments — between investors and host states. If an investor dispute cannot be settled amicably within 3 months, investors may choose to submit it for resolution to the courts or administrative tribunals; any previously agreed dispute settlement procedure; or international arbitration or conciliation.
In force since 1998
The Energy Charter Treaty entered into force in April 1998, with amendments on trade-related provisions. Russia, however, has never ratified the ECT and ended its provisional application in 2009 for preserving Gazprom’s monopoly on its gas exports to Europe, notably from Turkmenistan. Italy has remained the only EU country to withdraw from the ECT in 2015. The global importance is also highlighted by the fact that another 30 countries and four African organisations are interested to join the ECT.
In May 2015, a new ’International Energy Charter’ was adopted and signed as a further political declaration by over 65 countries (including the U.S., Canada, and China) and organisations, including the EU and all EU countries. The purpose of this new charter is to engage as many new countries as possible who are willing to cooperate in the field of energy and who recognise the importance of energy security for energy producing, -transit and -consuming countries likewise.
The new charter builds upon and modernises the Energy Charter of 1991 by identifying and agreeing on common principles and areas of international cooperation in the field of global energy challenges for the 21st century. Meanwhile, over 90 countries from all continents are involved in the Energy Charter process committed to the observance of its principles of open and non-discriminatory energy markets.
Balancing various interests
The European Commission and most member states have recognised the problem to bring the ECT more in line with its own new political ambitions and the agreed targets of its EGD and its faster decarbonisation policies. Alongside of the EGD and contrary to the demands of a more radical climate policy for ending now all fossil fuel investments, the present proposal of the Commission for reforming the ECT still envisages investments into new gas power plants for at least the next 10 years. Gas pipelines now will be protected until the end of 2040 as gas will be needed even beyond 2030.
Gas pipelines and other gas infrastructures might also be used for transporting hydrogen and expanding its industry options. The new investment protection under the ECT will promote the expansion of hydrogen, biomass, and other new clean energy options.
The “sunset clause”
Withdrawing from the treaty won’t solve the challenges as it could trigger a ‘sunset clause’ under which investors can still sue governments for another 20 years. As the German agreed coal-phase-out has demonstrated this year, a faster political decision to phase-out coal power plants can lead to indirect expropriation under national laws or the ECT and may cost governments billions of Euros. The compensation claims led to non-public negotiations between the companies and the German government over the shutdown of the last coal power plants in 2038 and has cost the German government some €5 bn in compensation as otherwise the companies have the right to a lawsuit against the German government based on Germany’s constitutional Basic law.
The ‘sunset clause’ is one of the reasons why the Commission and its member states are favouring renegotiation and modernisation rather than to terminate and scrap the ECT. The Court of Justice of the EU already ruled in 2018 that investment protection clauses in the ECT are illegal if they were agreed between two EU members as the EU law offered sufficient protections for investors, while circumventing public courts undermine the EU’s legal system.
The foreign policy perspective
But the challenges are different with other countries and non-European companies as well as foreign investors involved – particularly when no rule-of-law is guaranteed in other countries. The ECT has always also been an important instrument of the EU to promote the rule of law in other countries – particularly in the EU’s neighbourhood countries such as in Central Asia. The ECT with the strategic objective to promote the rule of law has become one of the most important instruments in the EU’s overall Central Asia and neighbourhood policy as well as in its relations with many other countries in the world.
Tristan Oil in Kazakhstan
A present example of the ECT’s importance is the situation facing bondholders in Tristan Oil, including US based hedge fund Argentem Creek Partners, which manages emerging market focused funds and which is backed by, amongst others, US pension funds. In 2006, it bought bonds issued by Tristan Oil which was owned by a Moldovan owner. The company had developed oil assets and was producing oil in western Kazakhstan. In 2010, after a coordinated campaign of harassment by various governmental bodies, Kazakh authorities forcibly nationalised Tristan’s assets.
In December 2013, as part of the ECT dispute resolution process, a Swedish arbitration panel ruled in favour of Tristan’s owners and that the Kazakh government had indeed orchestrated the illegal take-over of the company. The panel ordered the Republic to pay over US$500 million in compensation and damages to Tristan Oil’s now former owners and in turn those owners agreed to share the proceeds with their former bondholders. Subsequently, other courts in Sweden, the U.S., Italy, Luxembourg, Belgium, France and the Netherlands have all recognised the Swedish award of 2013 and in Sweden the SVEA Appeals Court and Swedish Supreme Court have also upheld the award.
Despite it being fully adjudicated in Sweden, Kazakhstan is still refusing to accept the ruling’s award. By initiating third-party lawsuits to play for time it is also hurting its own interests by raising foreign investor’s risk assessments of the country.
Without the ECT, this situation and many other similar situations would be much worse for all sides: for foreign investors, the stakes and risks would be much higher to invest in Kazakhstan and other countries without a guarantee to respect the rule of law – at least the ECT gives investors a mechanism to deal with disputes even if Kazakhstan selectively respects these rulings. The EU would lose its only multilateral treaty that protects energy investments and promotes the rule of law with strong investment incentives, including green energy projects. Kazakhstan and other countries, which are often struggling with the requirements of the rule of law, would face much more challenges for attracting foreign direct investments (FDI).
Yukos Oil in Russia
By far the largest investor-state dispute of this kind concerns one of Russia’s most successful companies, Yukos Oil. In 2014, an independent international Arbitral Tribunal in The Hague ruled unanimously that Yukos Oil was illegally expropriated by the Russian Federation, which was found to have breached its obligations under the ECT. The Tribunal awarded compensation of $50 billion to former Yukos majority shareholders. The Arbitral Award was then fully reinstated by The Hague Court of Appeal on 18 February 2020, overturning a 2016 ruling of the District Court that had set them aside. The Russian Federation refuses to pay, resisting every attempt to enforce the award.
Both ongoing cases are symptomatic of how authoritarian states are manipulating democratic and judicial institutions across Europe and the US. The ECT, therefore, represents the most important multilateral instrument for protecting not only shareholders, but also the rule of law.
Changing the ECT requires unanimity
But like many other multilateral treaties, it requires unanimity to change the entire ECT. That appears indeed rather unrealistic at least in the short-term. Beyond the slow negotiation progress of a reformed ECT, the critics are overlooking manifold foreign policy implications and inherent democratic requirements – even of the rule of law in the European countries themselves – by their calls for terminating the ECT:
- Commercial energy investments for both fossil fuel projects, and renewables have mostly a mid-term investment timeframe of 20-40 years as otherwise they are hardly profitable. If rapid policy changes – be it for climate or other reasons – can lead to the loss of investments or devalue the invested assets, hardly any private investor (especially Western pension funds) will undertake those long-term investment risks. Neither the EU nor its member states nor any other country in the world, however, will be able to fund a rapid energy transition to a renewable-based energy system alone by using just public funds. The present hydrogen initiatives are just one example that huge private investments are needed in addition to public ones to realise its industry-scale ambitions, albeit no one can really assure the realisation of a hydrogen-based energy system in the EU as well as a worldwide build-up of a much-needed hydrogen industry. A more rapid energy transition and decarbonisation demands more private investments and not less. Increasing the risks for investors will neither accelerate nor realise any sustainable European or global energy transition.
- The very rule of law in the EU democracies give commercial investors adequate guarantees against governments changing the rules of the game for long-term investments without a justified compensation on which private investors have to rely on when making costly investments. All past investment decisions in costly fossil fuel projects demanded cooperation and a common investment understanding between the national economic ministry, federal governments, the industry, and non-industry investors. Terminating the ECT, other treaties and similar rights granted in national laws for private investments would tremendously decrease much needed commercial investments and hurt even the very rule of law in democracies themselves where private investments and private ownership are secured by law. It opens the door for any populistic policies and a renationalisation of private ownership justified by climate policies today and other proclaimed reasons in the future. Ultimately even the rule of law itself would be subordinated to any arbitrary climate policies. Therefore, the European Commission and member states such as Germany have proposed to refer investor-state dispute settlements to a future “Multilateral Investment Court” (which is currently being negotiated internationally) rather than to the much-criticised private arbitration courts.
- Terminating the ECT would also undermine the EU’s neighbourhood and global foreign as well as international trade policies and its self-claimed leadership for multilateralism. Scrapping the ECT might lead to even more international trade and investment conflicts and renationalisation in the global energy sectors. This is the opposite of what the world needs to fight global climate change more successfully.
- Any policy of isolating the worldwide oil and gas producers and not taking into account their strategic interests for diversifying their economies and changing their investments into renewables will make a faster decarbonisation even more unrealistic. Just criticising them, offering no incentives, and not addressing their strategic interests in an enhanced cooperation with them will only lead to more open political opposition on their side and make the global climate policy ambitions even more unrealistic. Also internationally, any rapid energy transition and decarbonisation needs more (and not less) cooperation, common investment rules, principles and agreed dispute settlements. Does really anybody believe that the EU can enhance its global role and influence by dictating to others to just follow its ambitious energy and climate policies by terminating multilateral treaties unilaterally, tarnished by its self-perception and illusion of ‘leading by example’?
- Critics also overlook the fact that the ECT doesn’t just protect oil and gas companies or market investors, but also ordinary people. The majority of pension funds is still investing in fossil fuel projects, including public sector pensions. Most pension funds refuse to divest (even when they generally support the decarbonisation and investments in green energies) because it would cost their members hundreds of millions as new analyses have highlighted. OECD pension funds are estimated to jointly manage €238-€828 bn and could be at risk by faster global fossil fuel divestment without engaging fossil-fuel producer countries. Therefore, they remain interested in the ECT and the respect for the rule of law as the ECT remains the only multilateral guarantee for FDI. Otherwise, any divestment policies without these investment guarantees could hurt millions of Western pensioners by much lower pension returns. New analyses also conclude that even a large-scale co-ordinated divestment is unlikely to directly influence fossil fuel production and mitigate GHG emissions. It may even inadvertently transfer assets to ‘neutral investors’ who are disinterested in supporting climate change policies and may develop new vested interests in fossil fuel projects regardless of EU climate and divestment policies.
Modernise the ECT to support the transition
Of course, multilateral treaties and political frameworks need to be modernised and reformed due to new global energy, climate, or other policies as well as technological innovations and developments. The ECT’s investment protection provisions have not been updated since the 1990s and, therefore, need to be updated for sufficiently meeting the new energy and climate policy commitments.
But even today, the ECT does not hinder the promotion and expansion of renewables. The granting of investment protection is based on the principle of the rule of law and cannot be made dependent on particular energy sources despite the overall importance of climate policies as the German and other EU governments have underlined. But at the same time, the ECT needs to support the EU’s agreed energy and climate policies as well as its global commitments.
Changing international treaties and frameworks is often difficult and time-consuming by their very nature. But terminating them unilaterally without anticipating the potential cascading impacts on overall global trade and foreign policies or disregarding enshrined principles of the rule of law inside the EU itself as well as by promoting it abroad is a recipe for disaster and will produce the opposite of what those critics understandably want to support.
They also overlook the impacts on the EU’s own future energy security. While the European dependence on oil and gas imports will continuously decline (particularly after 2030), its dependence on imports of critical raw materials (CRMs) for renewable energies and decarbonisation technologies as well as high volumes of hydrogen supplies will rapidly increase from other continents.
The concentration of mining, production, and refinement of many CRMs in a few countries (particularly in China) is much higher than the remaining oil and gas resources and, thereby, often in sectors which are still much less regulated for environmental protection and climate-related emissions mitigation.
More cooperation is needed, not less
Hence the EU’s new import dependencies also demand much more cooperation, common investment rules, principles and guarantees for commercial investments and addressing the new supply chain related emissions for decarbonising the world’s energy, mining, and other industry sectors. The newly adopted International Energy Charter and further reforms as well as modernisations of it are the only way to guarantee sufficient FDI (including private and institutional investments from Western pension funds) as otherwise the global decarbonisation efforts will remain a chimera.
The proposal to withdraw from the ECT also highlights an ignorance towards the EU’s wider foreign and geopolitical interests, and a dangerous lack of empathy and political willingness to take the strategic interests of non-EU countries into account.
If the EU wants to further marginalise its global role and geopolitical influence and let climate policies dictate solely the EU’s entire foreign policies, this lack of strategic thinking is indeed the perfect way to go – including losing any future influence in mitigating global climate change in global fora.
Frank Umbach is Research Director at the European Cluster for Climate, Energy and Resource Security (EUCERS)
- See Maiya Keidan/Carolyn Cohn, ’British Pension Schemes Warn on Cost of Fossil Fuel Divestment’, Reuters, 20 January 2020. ↑
- See Arthur Rempel/Joyeeta Gupta, ‘Conflicting Commitments? Examining Pension Funds, Fossil Fuel Assets and Climate Policy in the Organization for Economic Co-operation and Development’, Energy Research & Social Science 69, 2020, 101736. ↑
- See ibid., p. 2. ↑
Floris van Nouhuijs says
I’m pleased to read this informative article as it clearly add’s to the debate with a lot of legitimate and valid points. However, the source used for building the case that pension funds would have lower yields if they divested from fossil fuels no longer holds and should be considered outdated. Even taking out the effects of COVID, the large asset write downs of leading fossil fuel companies such as BP, Shell and even Exxon are indicative of lower expected future prices for at least oil and likely also LNG. Overall the renewables sector has shown more resilience during the COVID downturn. So if Reuters would now redo their survey among pension funds it’s likely responses would be different. All this without considering the question why returns in the coming years would be more valuable to society and pensioners than truly sustainable returns further into the future for their children. Would grandparents really discount their grandchildren’s future (returns) if asked in a straight forward manner? With even short term pensioners’ interests no longer aligned with aggressive fossil fuel expansion, the question becomes irrelevant.